Many investors think that a big deal is made out of personal financial planning. They say that, if you save regularly and invest wisely, then you will be able to meet most of your goals. However, investors without a well structured financial plan may end falling short of their financial goals. At different stages of life, different goals seem relatively more important to us. For example, if you are in your early thirties and do not own a house, buying a house may seem to be a very important goal. Retirement, which is twenty five or thirty years away may not seem to be a very important goal. On the other hand, if you are in your twenties and recently married without children, children’s college higher education is so far away, that you may not really be concerned about it. However, over your entire saving and investing lifecycle, are any of these goals less important? No, all the goals are very important. Your financial plan will help you to be ready for each of the financial steps in your life. In this article we will discuss, how personal financial planning will help you.
- The first step of financial planning is to define specific goals. The more specific the goals are the better. Sometimes, especially if you are young, you may not have enough clarity about all the financial goals in your life. This is where an expert financial planner or adviser can help you. He or she can help you define the goals across your savings and investment lifecycle. He or she can then, help you determine the specific numbers you need to reach specific goals. For example, if you want to buy a house in a particular neighborhood five years later, your financial planner can help you determine how much corpus you will need, based on several factors like current property prices in that neighborhood, real estate appreciation trends, inflation, down payment requirements etc. He or she can help you to determine, how much you need to save and invest each month to meet your goals. You financial planner will also make recommendations on the type of investments you should use to reach those goals. For example, if you have a short to medium term goal, your financial planner will calibrate your asset allocation, towards that particular goal appropriately. On the other hand, if you have a long term goal, your financial planner will recommend a more aggressive asset allocation.
- Budgeting is the next step of financial planning. This is probably the most important step of financial planning, because even if you have the most detailed and well structured financial plan, if you are not able to save enough, you will not be able to meet your financial goals. Saving habits are very personal. It depends on our lifestyle, relative to our income levels. Some of us, irrespective of our income levels, are very careful about expenses. Others are more extravagant as far as spending is concerned. The objective of a good financial plan is to enable you to meet your short term or long term financial goals, without having to sacrifice the lifestyle commensurate with your income. This is where a thoughtful budgeting exercise is very useful. Your budget allows you to plan how to spend your money. It makes it easier to find ways to save money. While financial planner or adviser may not actually prepare your budget, he or she can give you guidance on how to find additional savings in your budget. In a budgeting exercise, the devil is in the details. Therefore, you should not skip even minor details when preparing your budget. Through a careful budgeting exercise, you may be able to identify expenses, which you can easily reduce, with any noticeable impact on your lifestyle. Sometimes, it is not just about reducing consumption, but also negotiating lower prices, for the goods and services you consume. Some costs may seem too small to bother about. But even small additional savings can make a big difference to your long term wealth, with the help of power of compounding. Just to give an example, even an additional Rs 500 monthly savings, invested in equity assets yielding 20% return, will generate a corpus in excess of Rs 1 crore over 30 years. On the other hand, even with the most rigorous budgeting exercise, you may not be able to save what you need to meet your financial goals. In that case, we will have to realistic about our goals. Your financial planner or adviser will help you re-calibrate your financial goals, either by postponing the goal timelines or re-adjusting the goals. Not all financial objectives can be postponed. For example, your children’s higher education or your retirement cannot be postponed. On the other, you can postpone your car purchase or house purchase. Your budget will play an essential part of making your overall financial plan work.
- Financial plans help you prepare for big events in your life. These events like, house purchase, your children’s higher education, your children’s marriage etc, have a big impact on our lives. Some people rely on making windfall gains, like getting a big bonus or an unusually big profit on their investment, to be ready for these events. You should prepare for these events, instead of leaving them to chance. Unless you have enough savings and investments, you will not have enough money, one fine day, to make the down payment for house purchase. You should start preparing for it early enough. Similarly, you cannot wait till your child is sixteen to start preparing for his or her higher education. You need to start much earlier. Financial planning helps you inculcate, disciplined savings and investment practise. Once you have developed a robust financial plan and have started executing on it in a disciplined fashion, your preparation for the big events in your life will be on auto pilot.
- Financial plans give you a head start in meeting your financial objectives, especially if you are young. For many young people, saving and investment is not an important priority. However, as with anything else in life, starting to invest from early age has great benefits. The earlier you start, the better are the chances for creating wealth as you get more return for more time on your investments. Please read our article, Why you should start investing early, to understand the benefits of having a financial plan and committing to it, when you are young. Financial planning and investing is often a daunting task for young people. You are not sure about your specific long term goals. This is where an experienced financial planner or adviser can help you. Working with a financial planner is most beneficial if you are young.
- Financial planning will help you make the right investment decisions. Asset allocation is one of the most important aspects of financial planning. How you invest your savings (debt or equity or real estate), makes a big difference, to your long term wealth. A lot of investors allocate a sub-optimal proportion of their portfolio to equities. This is because the risk appetite of investors in India is low. A financial planner or adviser will provide guidance to investors with regards to their asset allocation strategies, in order to meet their short term, medium term and long term financial objectives.
- Having a financial plan helps you prepare for contingencies. Contingencies are unforeseen events that can cause financial distress. The worst case contingency is an untimely death, which can result in financial distress for the family, apart from the emotional trauma. Financial planning can help us prepare for such contingencies through adequate life insurance (please refer to our article, How much life insurance is adequate). Another contingency is serious illness that can have an impact on your savings and consequently your short term or long term financial objectives. A good financial plan will make adequate provisions for health insurance. There can be other contingencies like temporary loss of income or major unforeseen expenditures. Financial plans will help you prepare for such contingencies.
In this article we have discussed, how personal financial planning can help you meet your short term, medium term and long term financial objectives. You should engage with an expert financial adviser, to help you prepare your financial plan and execute on it. In our next article, we will discuss some important steps in the financial planning process.